Dallas Fed: We cannot stimulate prosperity

By Kurt Brouwer

To be fair, the Dallas Fed did not exactly say we cannot stimulate prosperity. Instead, they released a piece asking if it can be done. In it, they pointed out that government stimulus efforts have not lived up to expectations so far. By the way, the high-powered economic insights of the Dallas Federal Reserve are well known, but in this one case they did lag FundmasteryBlog by months. In fact, back in June I wrote a post asking a very similar question, Can we spend our way to prosperity? Now, the Fed is following my lead (kidding of course) by releasing this report that asks [emphasis added]:

Compared with no stimulus, the stimulus plan in 2009 alone was expected to increase GDP by 1 to 3 percentage points, raise payroll employment by 500,000 to 1 million jobs and lower the unemployment rate by half a percentage point.

At first glance, it doesn’t appear the stimulus achieved these objectives. In the year after the plan’s passage, the labor market continued to hemorrhage jobs and unemployment climbed above 10 percent. Indeed, the unemployment rate is now higher than it was expected to be without the stimulus plan—and has been every month since the plan’s passage (Chart 5).

This chart takes as a starting point, the projection made by two White House economists, Christina Romer and Jared Bernstein, in January 2009. The projection was used to sell the $787 billion American Recovery and Reinvestment Act, which was being debated then. The two economists bravely predicted what would happen with unemployment assuming economic stimulus passed (red line) or did not pass (green line).

The blue line, of course shows what actually happened. Unfortunately, unemployment is at 9.5% now, not less than 7% as the White House economists predicted it would be by now. Even at that, 9.5% is misleading. The only reason unemployment is not higher is that the government does not count millions of newly-discouraged workers as being unemployed.

Stimulus spending: too much or not enough?

We have been hearing from some academics, politicians and pundits that the only way out of the current economic malaise is to ramp up government stimulus spending even more. The argument goes somewhat along these lines: Consumers and businesses are paying down debt and cutting back on spending, so the only way to repower the economy is for government to step in and provide economic stimulus by spending lots and lots of money.

The fact that this seemingly-limitless spending will lead to enormous budget deficits is deemed by spending fans to be unworthy of serious consideration because this stimulus will eventually work like magic and then the economy will start growing rapidly. At that point, a wise and benevolent government will cut spending and raise taxes and everything will be just peachy.

Fool me once, shame on you; fool me twice…

I have little faith in the stimulative impact of much of the government spending we have seen so far. At a minimum, I’d like to see those who advocate higher and higher levels of spending address what went wrong with their projections from 2009. Just saying it would have been much worse without the stimulus is not enough.

Also, I’d like to see some historical evidence that additional trillions in spending has worked before. Here is a table from the Great Depression showing government spending increases and unemployment levels coupled with GDP or economic output.

In the aftermath of the 1929 stock market crash and subsequent economic debacle, government spending ramped up dramatically as the following table shows. After 10 years of higher spending, higher deficits and increased government intrusion into the economy, the results were poor indeed.

For example, in 1938, the unemployment rate was 19.1%, six times the 1929 level of 3.2%. Economic ouput in 1938 was below the 1929 level and government spending was still more than twice the 1929 level. In fact, the stagnant economy did not decisively break out of the malaise until World War II ended, almost two decades years after the crash of 1929.

I do not believe we can spend our way to prosperity any more than I believe someone can get out of debt by borrowing more. Government spending and the various bailouts (AIG, GM, Chrysler, Fannie Mae) are achieving very little other than putting us further into debt and kicking the can down the road.

Excessive spending & leverage got us in this mess

In my opinion, we need to take the hit now even if it means that we might slide back into recession. There is no way out that I can see that does not constitute pain and suffering. We need to realize that spending and leverage are the twin evils that got us into this mess. They are not tools to get us out of this mess.

So in answer to the question posed by the Dallas Fed, I believe we cannot stimulate (that is, spend and borrow) our way to prosperity.

You may not agree with me, but I tried to present my thoughts as clearly and objectively as I can. If you think we can spend our way to prosperity, I’d like to see your plan with some actual evidence that a similar plan has worked in the past.

About Fundmastery Blog

Kurt Brouwer is a fee-only financial advisor with three decades of experience. He is the chairman and co-founder of Brouwer & Janachowski, LLC. Kurt has written books, articles and hundreds of blog posts on mutual funds, ETFs and other investment topics. E-mail: kurt.brouwer *at* gmail.com.